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Texas Court of Appeals American Multi-Cinema Case: Sequel and Prequel

Daily Tax Report: State provides authoritative coverage of state
and local tax developments across the 50 U.S. states and the District of
Columbia, tracking legislative and regulatory updates,...

Tax Policy

Litigation over the Texas franchise tax “cost of goods sold” calculation continues
to wind its way thought the courts due to confusion over what exactly can be counted
in the deduction. In this article, Sam Megally and William J. LeDoux of K&L Gates
LLP discuss the American Multi-Cinema case, which addressed not only how cost of goods
sold is determined, but also which taxpayers are entitled to use it.

By Sam Megally and William J. LeDoux

Sam Megally is a partner and William J. LeDoux is an associate at K&L Gates LLP in
Dallas, Texas.

On Jan. 6, 2017, the Austin Court of Appeals issued a
new opinion (the 2017 opinion) in the pending Texas franchise tax case
American Multi-Cinema, Inc. v. Hegar (No. 03-14-00397-CV), replacing an
April 2015 opinion (the 2015 opinion) that had relied on a different—and arguably broader—statutory
provision. The
American Multi-Cinema Inc. (
AMC) case began as a dispute over a movie theater company's claim that it was entitled
to calculate its Texas franchise tax by subtracting as costs of goods sold (COGS)
all costs associated with exhibiting films, including certain costs associated with
the square footage of AMC's auditoriums. Qualification for the COGS calculation can
be beneficial for some taxpayers; in AMC's case, using a different franchise tax calculation
method would have resulted in a greater franchise tax liability. In the 2015 opinion,
the Austin Court of Appeals construed the meaning of the term “goods”
by reference to a statutory definition of tangible personal property that includes
personal property “perceptible to the senses,”
and concluded that AMC sold such goods and therefore qualified to use the COGS calculation.
In the 2017 opinion, the court instead based its determination—again in the taxpayer's
favor—on a narrower, industry-focused definition of tangible personal property that
includes films, sound recordings, books, television and radio programs, and similar
property. The court also expressly declined in the 2017 opinion to address the broader
definition of tangible personal property on which it had relied in the 2015 opinion.
As of the date of this publication, the 2017 opinion is not final and could change,
including as a result of an appeal to the Texas Supreme Court.

Following the 2015 opinion, there was much discussion both among taxpayers and in
the Comptroller's office about the possible fiscal implications of the court's decision.
In the summer of 2015, the Comptroller's office
estimated the potential impact of the 2015 opinion at up to $1.5 billion per year in lost tax
revenue; in December of 2016, just before the court issued the 2017 opinion, the Attorney
General's office
notified the court that the 2015 opinion had led to COGS claims from taxpayers that sell “experiences,”
including an aquarium and a country club. Some practitioners and taxpayers perceive
the court's decision to substitute the 2017 opinion for the 2015 opinion as a response
to speculation about potential economic fallout arising from refund claims and lawsuits
seeking to make the COGS calculation available to taxpayers in virtually all industries.
The Texas taxpayer and practitioner communities have generally been critical of courts
that have based their statutory interpretations in part on fiscal concerns rather
than on the language of the provisions before them. Regardless of the court's motivation
for issuing the 2017 opinion, some taxpayers that have already filed refund claims
or lawsuits or started calculating their franchise taxes based on the reasoning in
the 2015 opinion may encounter Comptroller resistance. Because the 2017 opinion expressly
declined to address the broader statutory provision supporting the 2015 opinion, additional
litigation is likely to continue for companies selling products other than those encompassed
in the industry-specific statutory provision.

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